What is LTV:CAC and why SaaS companies care about it?

A few weeks ago, I was in the process of analyzing a very interesting SaaS company that is currently raising their A round. Without going too deep into the details (and of course honoring their request for discretion), I was really impressed by a single metric used to track their performance which is the LTV:CAC. It was a double digit number which blew me away but also caused me to question their numbers. Just to give you some perspective, in a recent article, Andrew Chen of A16Z (Andreessen Horowitz), mentioned a rule of thumb of LTV:CAC > 3.

To understand LTV:CAC, we need to break it down into it’s individual pieces:
LTV stands for life time value, which is basically how much revenue will a client pay to the company. CAC is the Customer Acquisition Cost, and is used as an efficiency metric for the marketing and sales departments. By dividing the LTV by the CAC, we actually get the client profitability.

Let’s look at a few examples of this metric:
Company A has a great marketing team who by using paid marketing, got their customer acquisition cost (CAC) to $15. However their clients average $20 in revenue lifetime (LTV). Taking their LTV and CAC, we can conclude that their LTV:CAC = 1.33
Company B acquires their clients in a different manner and their CAC is $35, while this is significantly higher than company A, their product sells for an LTV of $160. Taking these numbers, we can see that LTC:CAC = 4.57.
What does this mean? That for every $1 invested in getting more clients, company A makes $1.33 while company B makes $4.57 for the same client cost. Assuming that the CAC and LTV remain pretty static, you can see that company B operates in a more efficient manner than company A.

While the LTV:CAC metric is significant to SaaS companies to measure their profitability, it does have some caveats to it:
1. It needs to be statistically significant, so selling to a couple of clients and calculating the LTV:CAC metric from it does not mean much. This is a metric best used for scale so I would hesitate to use it for companies with under a few dozen clients.
2. Most SaaS companies measure their revenue in MRR (monthly recurring revenue). Before LTV can be calculated, we need to figure out how long will the client keep paying the monthly fee.
3. CAC assumes actual sales and marketing effort. Companies not using paid media or any other form of marketing will have a hard time calculating a realistic CAC.
4. Both CAC and LTV constantly change as the company’s product and marketing evolve. These numbers need to be constantly monitored and verified

If you’ve got some questions on this article or have an insight you’d like to share, please comment here